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The Income Tax Treatment of Social Welfare Benefits

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The Income Tax Treatment of Social Welfare Benefits University of Michigan Journal of Law Reform Volume 26 1993 The Income Tax Treatment of Social Welfare Benefits Jonathan Barry Forman University of Oklahoma Follow this and additional works at: https://repository.law.umich.edu/mjlr Part of the Social Welfare Law Commons, Taxation-Federal Commons, and the Tax Law Commons Recommended Citation Jonathan B. Forman, The Income Tax Treatment of Social Welfare Benefits, 26 U. MICH. J. L. REFORM 785 (1993). Available at: https://repository.law.umich.edu/mjlr/vol26/iss4/4 This Symposium Article is brought to you for free and open access by the University of Michigan Journal of Law Reform at University of Michigan Law School Scholarship Repository. It has been accepted for inclusion in University of Michigan Journal of Law Reform by an authorized editor of University of Michigan Law School Scholarship Repository. For more information, please contact [email protected]. THE INCOME TAX TREATMENT OF SOCIAL WELFARE BENEFITS t Jonathan Barry Forman* The United States operates a multibillion dollar social welfare system of enormous size and complexity.1 Millions of Americans receive benefits under such social welfare programs as Social Security, Aid to Families with Dependent Children (AFDC), and food stamps. The federal government alone will spend approximately $650 billion on social welfare programs in fiscal year 1994.2 Internal Revenue Service rulings historically have exempted social welfare benefits from income taxation.3 In the past fifteen years, however, Congress has expressly subjected unemployment compensation and a portion of Social Security benefits to income taxation.4 This Article considers whether income taxation should be extended to other social welfare benefits. In particular, this Article discusses the appropriate- ness of taxing AFDC, Supplemental Security Income (SSI), Medicare, Medicaid, food stamps, housing assistance, and workers' compensation. Part I of this Article describes the major social welfare programs in the United States. Part II outlines the basic structure of the federal income tax and describes how social t © 1994 Jonathan Barry Forman. All rights reserved. * Professor of Law, University of Oklahoma. B.A. 1973, Northwestern University; M.A. (Psychology) 1975, University of Iowa; J.D. 1978, University of Michigan; M.A. (Economics) 1983, George Washington University. I would like to thank my research assistant Inga Ladd. 1. For a detailed analysis of the complexity of the social welfare system, see Jonathan B. Forman, Administrative Savings from Synchronizing Social Welfare Programsand Tax Provisions, 13 J. NAT'L ASS'N ADMIN. L. JUDGES 5 (1993) [hereinaf- ter Forman, Administrative Savings] (long version); Jonathan B. Forman, Synchro- nizing Social Welfare Programsand Tax Provisions, 59 TAX NOTES 417 (1993) (short version). 2. STAFF OF HOUSE COMM. ON WAYS & MEANS, 103D CONG., 1ST SESS., OVERVIEW OF ENTITLEMENT PROGRAMS-1993 GREEN BOOK 1767 (Comm. Print 1993) [hereinafter 1993 GREEN BOOK]. Note that more than $485 billion in expenditures is attributable solely to Social Security and Medicare payments. Id. 3. E.g., I.T. 3447, 1941-1 C.B. 191 (holding that Social Security benefits "are not subject to Federal income tax"), superseded by Rev. Rul. 70-217, 1970-1 C.B. 13 (holding that Social Security benefits "are not includible in gross income" and therefore are not taxed). 4. See infra Part II.B.1, 3. 786 University of Michigan Journal of Law Reform [VOL. 26:4 welfare benefits are treated by the income tax system. Finally, Part III surveys some recent proposals to tax particular social welfare benefits and considers the arguments for and against taxing such benefits. The Article concludes that the need for new revenue sources will push the federal government to reconsider the tax treatment of social welfare benefits. I. OVERVIEW OF THE AMERICAN SOCIAL WELFARE SYSTEM Dozens of social welfare programs provide assistance to individuals for retirement, disability, health, education, hous- ing, public assistance, employment, and other needs.' The vast majority of these social welfare programs transfer cash or in-kind benefits, such as food or medical care, directly to individuals.6 Social welfare policy analysts generally differentiate between transfer programs that are "means-tested" and those that are not. Eligibility and benefits for means-tested programs like AFDC, SSI, Medicaid, food stamps, housing assistance, and energy assistance depend upon an individual's need, as measured by the individual's income and assets. Eligibility for non-means-tested programs, like Social Security and Medicare, is based on other criteria such as age and work history. A. Means-Tested Programs 1. Aid to Families with Dependent Children-Aid to Families with Dependent Children7 (AFDC) provides cash 5. Indeed, some 75 federal programs provide such assistance to low-income individuals. NATIONAL COMM'N FOR EMPLOYMENT POLICY, COORDINATING FEDERAL ASSISTANCE PROGRAMS FOR THE ECONOMICALLY DISADVANTAGED: RECOMMENDATIONS AND BACKGROUND MATERIALS ix, 3 (1991); see also Low INCOME OPPORTUNITY WORKING GROUP, DOMESTIC POLY COUNCIL, UP FROM DEPENDENCY: A NEW NATIONAL PUBLIC ASSISTANCE STRATEGY 9-15 (1986) (listing 99 low-income assistance programs). 6. Social welfare assistance which is not transferred directly to individuals (such as education grants to schools) and transfers to individuals which are not directly related to social welfare (such as farm subsidies) are beyond the scope of this Article. Similarly, programs providing social welfare assistance to individuals indirectly, such as the exclusion of life insurance proceeds from gross income, I.R.C. § 101(a)(1) (1988), are generally beyond the scope of this Article, as are the various loan and loan guarantee programs, such as the student loan program. 7. 42 U.S.C. §§ 601-687 (1988). SUMMER 1993] Taxation of Welfare Benefits assistance and other services to needy families with dependent children to allow them to become self-sufficient.8 AFDC provides cash welfare payments through the states for: (1) needy children who have been deprived of parental support or care due to a parent's incapacitation, death, unemployment or continuous absence from the home; and (2) certain others in the household of a child covered by the program.9 Individual states define the term need, determine benefit levels, establish income and resource eligibility limits within federal guidelines, and administer or supervise the adminis- tration of the program in their state. The federal government pays fifty to eighty percent of AFDC costs. AFDC payments vary dramatically from state to state because each state sets different benefit levels. For example, in January 1993, the maximum monthly grant that an AFDC family of three could receive ranged from $120 in Mississippi to $923 in Alaska. ° In fiscal year 1992, the AFDC program had a nationwide, average monthly caseload of almost 4.8 million households, or 13.6 million persons." The program provided $22.2 billion in total benefits in fiscal year 1992 and cost a total of $2.7 billion to administer. 12 In fiscal year 1992, monthly AFDC benefits 13 averaged $136 per person and $388 per family. 2. Supplemental Security Income-Supplemental Security Income (SSI)14 is a federal program that provides cash benefits to needy persons who satisfy the program's criteria for age, blindness, or disability.'5 In 1993, the regular federal benefit was $434 per month for an individual, and $652 per month for a couple.' 6 In 1992, 5.6 million people received over $22.2 8. See id. § 601; see also 1993 GREEN BOOK, supra note 2, at 615 (describing the AFDC program and its eligibility requirements). 9. 42 U.S.C. § 606(a)-(b) (1988). In addition, many states also provide short- term emergency assistance or general assistance to persons not covered by AFDC. Although the tax treatment of these cash transfer programs follows that of AFDC, the details of these programs are beyond the scope of this Article. 10. See 1993 GREEN BOOK, supra note 2, at 655, 657-58. 11. ' Id. at 682. 12. Id. at 679. 13. Id. at 682. 14. 42 U.S.C. §§ 1381-1383d (1988). 15. See id. § 1382 (listing SSI eligibility requirements); see also 1993 GREEN BOOK, supra note 2, at 813-17 (describing SSI payments and eligibility requirements). 16. 1993 GREEN BOOK, supra note 2, at 823. Some states, however, provide small additional supplements. Id. at 823, 829-30. 788 University of Michigan Journal of Law Reform [VOL. 26:4 billion in SSI benefits. 17 In September of 1992, the average monthly benefit paid to an SSI recipient was about $350.18 3. Medicaid-Medicaid1 9 is a federal-state matching entitlement program which provides medical assistance for needy persons who are aged, blind, disabled, recipients of SSI and AFDC, and pregnant women and children with family incomes below 133 percent of the federal poverty income guidelines.2 ° States design and administer their programs within federal guidelines, and the federal government reim- 21 burses them for fifty to eighty-three percent of their costs. In fiscal year 1991, the Medicaid program served 28.3 million people at a total cost of $77 billion.22 The average annual expenditure per person was $2725.23 4. Food Assistance-Several social welfare programs provide food assistance to needy households. The largest of these, the Food Stamp Program,24 is administered by state agencies operating under the supervision of the U.S. Depart- ment of Agriculture.2 ' The federal government fully finances food stamp benefits and reimburses one-half of a state's administrative expenses.26 In general, food stamp benefits are issued in coupon booklets which are used by participating households to buy food items for home preparation and consumption. The amount of benefits is related to the household's size, its adjusted monthly income, and a maximum monthly benefit level.27 In fiscal year 1992, the Food Stamp Program served 26.9 million people 28 at a total cost of $24.9 billion.29 Monthly food stamp benefits averaged $68.50 per person, or about $170 per household.30 17.
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